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The Company, a global reinsurance and insurance company, was incorporated under the laws of Bermuda in October 2005 and commenced operations in December 2005. The Company is currently organized into two business segments: Reinsurance and Insurance. Through our Reinsurance segment, we write primarily property, property catastrophe and short-tail specialty and casualty reinsurance. Through our Insurance segment, we primarily write property insurance for homes, condominiums and office buildings in the Caribbean region. In addition, beginning in 2009 as a result of our recent acquisition of Marlborough, the managing agency for Lloyd's Syndicate 1861, the majority of the business written through Lloydâ€™s Syndicate 1861 will also be included in the Insurance segment. We diversify our risks across business lines by risk zones, each of which combines a geographic zone with one or more types of peril (for example, Texas Windstorm, Florida Hurricane or California Earthquake). The majority of our reinsurance contracts contain loss limitation provisions such as fixed monetary limits to our exposure and per event caps. We specialize in underwriting where sufficient data exists to analyze effectively the risk/return profile, and where we are subject to legal systems we deem reasonably fair and reliable.

Our largest business is providing property catastrophe reinsurance coverage to a broad range of select insurance companies. These policies provide coverage for claims arising from major natural catastrophes, such as hurricanes and earthquakes, in excess of a specified loss. We also provide coverage for claims arising from other natural and man-made catastrophes such as winter storms, freezes, floods, fires and tornados. Our specialty lines, which represent a growing proportion of our business, cover such risks as aviation, energy, accident and health, agribusiness, satellite, space, marine and workersâ€™ compensation catastrophe.

Because we have a limited operating history and have grown and diversified our lines of business significantly during that time, period to period comparisons of our results of operations are limited and may not be meaningful in the near future. Our financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (â€śU.S. GAAPâ€ť) and our fiscal year ends on December 31. Since a substantial portion of the insurance and reinsurance we write provides protection from damages relating to natural and man-made catastrophes, our results depend to a large extent on the frequency and severity of such catastrophic events, and the specific coverages we offer to clients affected by these events. This may result in volatility in our results of operations and financial condition. In addition, the amount of premiums written with respect to any particular line of business may vary from quarter to quarter and year to year as a result of changes in market conditions.

We measure our financial success through long-term growth in diluted book value per share plus accumulated dividends measured over intervals of three years, which we believe is the most appropriate measure of the performance of the Company, a measure that focuses on the return provided to the Companyâ€™s common shareholders. Diluted book value per share is obtained by dividing shareholdersâ€™ equity by the number of common shares and common share equivalents outstanding.

We derive our revenues primarily from net premiums earned from the reinsurance and insurance policies we write, net of any retrocessional or reinsurance coverage purchased, net investment income from our investment portfolio, and fees for services provided. Premiums are generally a function of the number and type of contracts we write, as well as prevailing market prices. Premiums are normally due in installments and earned over the contract term, which ordinarily is twelve months.

On April 14 2008, Flagstone Suisse registered as a permit company in Bermuda under the Companies Act 1981 of Bermuda, as amended (the â€śBermuda Companies Actâ€ť) and operating through its Bermuda branch. Flagstone Suisse was subsequently registered as a Class 4 insurer under the Insurance Act 1978 of Bermuda, as amended (the â€śBermuda Insurance Actâ€ť).

On June 26, 2008, Flagstone Suisse purchased 3,714,286 shares (representing a 65% interest) in Imperial Reinsurance Company Limited (â€śImperial Reâ€ť). In July, 2008, the South Africa Registrar of Companies recorded a change of name from Imperial Re to Flagstone Reinsurance Africa Limited. Flagstone Africa is domiciled in South Africa and writes multiple lines of reinsurance in sub-Saharan Africa. This acquisition gives the Company access to business in a growing and attractively priced market.

On September 30, 2008, the Company completed the restructuring of its global reinsurance operations by merging its two wholly-owned subsidiaries, Flagstone Reinsurance Limited and Flagstone Suisse into one succeeding entity, Flagstone Suisse with its existing Bermuda branch. The merger consolidated the Companyâ€™s underwriting capital into one main operating entity, maximizing capital efficiency and creditworthiness, while still offering a choice of either Bermuda or Swiss underwriting access. Because both companies were wholly-owned subsidiaries of the Company, the merger did not result in any changes in the previously recorded carrying values of assets or liabilities of the merged entities.

During 2008, the Company acquired 100% of Flagstone Alliance, formerly known as Alliance International Reinsurance Public Company Limited (â€śAlliance Reâ€ť). In June 2008, the Company purchased 9,977,664 shares (representing 14.6% of Alliance Reâ€™s common shares) for $6.8 million and on August 12, 2008, purchased 10,498,164 shares (representing 15.4% of Alliance Reâ€™s common shares) for $6.8 million, from current shareholders. During September 2008, the Company acquired a further 4,427,189 shares on the open market. The remainder of the 43,444,198 shares were acquired during the fourth quarter of 2008. Flagstone Alliance, domiciled in the Republic of Cyprus, is a specialist property and casualty reinsurer writing multiple lines of business in Europe, Asia, and the Middle East & North Africa region. Flagstone Alliance holds majority ownership interests in subsidiaries that are involved in brokerage activities for insurance and reinsurance companies.

On November 18, 2008, the Company acquired 100% of the common shares of Marlborough Underwriting Agency Limited (â€śMarlboroughâ€ť), the managing agency for Lloyd's Syndicate 1861, a Lloyd's syndicate underwriting a specialist portfolio of short-tail insurance and reinsurance, from the Berkshire Hathaway Group. The acquisition does not include the existing corporate Lloydâ€™s member or any liability for business written during or prior to 2008. The Company also incorporated a new subsidiary, Flagstone Corporate Name Limited, which has been admitted as a corporate member of Lloydâ€™s. Flagstone Corporate Name Limited is currently the sole capital provider for Lloydâ€™s Syndicate 1861 for fiscal year 2009 onwards. No business that incepted in 2008 for the benefit of the Flagstone group was written by Marlborough during the remainder of 2008 following its acquisition by the Company. Marlborough and Syndicate 1861 provide us with access to the benefits of the Lloyds market which include access to a substantial flow of business, specialty underwriting talent, Lloyds worldwide credibility, strong credit ratings and licenses to write business in 79 countries around the world.

Business Strategy

The Company is in the business of taking two kinds of risk which we refer to as our Franchise Risks: these are insurance risk and investment risk. Our goal with respect to these risks is to be well rewarded for the risks we take, and well diversified so as to produce an acceptable return on equity with moderate volatility. The ultimate responsibility for the levels of Franchise Risk rests with our Executive Chairman and our Chief Executive Officer, reporting to the Board of Directors. We endeavor to minimize other risks such as operational and reputational risks, which we refer to as Enterprise Risks, and the responsibility for managing these lies with our Chief Enterprise Risk Officer, reporting to the Chief Operating Officer and to the Audit Committee.

Our two primary financial goals are to maintain multiple credit ratings in the â€śAâ€ť range, and to produce growth in diluted book value per share with moderate volatility. We believe that prudent management of our underwriting risks, relative to our capital base, together with effective investment of our capital and premium income, will achieve our financial goals and deliver attractive risk-adjusted returns for our shareholders. To achieve this objective, our strategies are as follows:

Maintain our Continued Commitment to Diversified and Disciplined Underwriting. We will continue to use our disciplined and data-driven underwriting approach to select a diversified portfolio of risks that we believe will generate an attractive return on capital over the long term. Neither our underwriting nor our investment strategies are designed to generate smooth or predictable quarterly earnings, but rather to optimize growth in diluted book value per share over a moving three-year horizon.

Continue Our Focus on Risk Management. We treat risk management as an integral part of our underwriting and business management processes. Substantially all of our reinsurance contracts contain loss limitation provisions, and we will continue to limit our net exposure under those contracts to any single event . This limits our absolute exposure to peak risk zones and produces what we believe to be a more balanced portfolio. Our strategy of limiting our exposure by risk zone means that we expect lower returns than some of our competitors in years where there are lower than average catastrophe losses but that our capital will be better protected in the event of large losses. With respect to our insurance business, we manage our aggregate risk through modeled probable maximum losses (PMLs) as well as maximum geographical concentrations. Island Heritage manages its risk to catastrophe exposure through the use of catastrophe reinsurance programs which limits our net exposure to both significant single and multiple catastrophe events. Additionally, in respect of our Lloydâ€™s business written, Flagstone Corporate Name Limited has limited liability therefore limiting exposure to the memberâ€™s available capital resources, which for this purpose comprises its funds at Lloydâ€™s, its share of member capital held at syndicate level and the funds held within the Lloydâ€™s Central Fund. For a discussion of Marlborough, please see â€śOther Jurisdictionsâ€”United Kingdomâ€ť below.

Leverage and Expand Our Strong Broker, Agent and Customer Relationships . We will continue to strengthen our relationships with brokers and customers and build our franchise. We will seek to enhance our reputation with brokers by responding promptly to submissions, as quickly as within one business day, if necessary, and by providing a reasoned analysis to support our pricing. Members of our senior management team will continue to spend a significant amount of time meeting with brokers and potential new clients and strengthening existing relationships.

Employ a Sophisticated Investment Approach . A substantial allocation of our assets have been invested in high-grade fixed maturity securities, with the remainder generally invested in a diversity of other asset classes, such as commodities, real estate, private equity, and cash equivalents. Allocation to asset classes other than fixed income and cash equivalents is currently below 4% of our investment portfolio. Our strategy has been designed to produce conservative total returns on our portfolio, allowing us to take advantage of the hardening cycle in the reinsurance markets, while still maintaining a very high quality portfolio with sufficient liquidity to pay potential claims and preserving our excellent financial strength rating.

Utilize Our Efficient Global Operating Platform . We will continue to integrate and grow our global operating platform. We believe that by accessing lower cost, yet highly educated and qualified talent, selected from certain of our locations outside of Switzerland, Bermuda and London, and integrating them into our operations through our technology platform, we will be able to achieve greater capabilities than other global reinsurance companies of comparable capital size.

Expand into Attractive Markets . Our management team has considerable experience in evaluating various market opportunities in which our business may be strategically or financially expanded or enhanced. Such opportunities could take the form of quota share reinsurance contracts, joint ventures, renewal rights transactions, corporate acquisitions of another insurer or reinsurer, or the formation of insurance or reinsurance platforms in new markets. We believe that the reinsurance and insurance markets will continue to produce opportunities for us, through organic expansion or through acquisitions, and that we are well qualified to evaluate and, as appropriate, take advantage of such opportunities.

Employ Our Capital Markets Expertise . The capital markets experience of our senior management team is being leveraged to access capital markets in innovative ways. For example, we created Mont Fort an entity that has raised capital from investors through offerings of its preferred shares, and uses the proceeds of those offerings to underwrite reinsurance ceded to it by Flagstone. Because we control both Mont Fort and Flagstone, and because Mont Fort benefits from Flagstoneâ€™s underwriting expertise and writes reinsurance only for Flagstone, this type of arrangement is often referred to as a sidecar. Through sidecars, we can optimize our retained risk profile while earning attractive fees for creating and managing these facilities. We have also participated in two catastrophe bond structures, Mont Gele Re Ltd. (â€śMont Geleâ€ť) and Valais Re Ltd. (â€śValais Reâ€ť), and each provides indemnity protection on our global reinsurance portfolio. Flagstone entered into a retrocessional reinsurance agreement with Mont Gele a Cayman reinsurance company. Mont Gele is a separate legal entity in which Flagstone has no equity investment, management, board interests or related party relationships. Under this agreement Mont Gele assumes an excess of loss agreement expiring on June 30, 2009. Mont Gele is required to contribute funds into a trust for the benefit of Flagstone equal to the protection provided under the excess of loss agreement. Valais Re is a special purpose reinsurer established in the Cayman Islands. The multi-year, economical coverage on an indemnity basis gives us more price certainty over the cycle and avoids the basis-risk inherent in index or parametric-based covers. In particular, we have the ability to access aggregate protection against multiple worldwide events that we believe would be hard to obtain in traditional markets. By diversifying our purchase of coverage into the capital markets we continue to reinforce our security for our clients and stockholders.

Preserve Our Financial Position . We will continue to manage our capital prudently relative to our risk exposures in order to maximize sustainable long term growth in our diluted book value per common share. Our strategy of limiting our exposure by risk zone means that we may achieve lower returns than some of our competitors in years with lower than average catastrophe losses but that our capital will be better protected in the event of large losses. For example, substantially all of our reinsurance contracts contain loss limitation provisions, and we will continue to limit our net exposure under those contracts to any single event. We are committed to maintaining our excellent capitalization, financial strength and ratings over the long term.

Segment Information

The Company is currently organized into two business segments: Reinsurance and Insurance. To better align the Companyâ€™s operating and reporting structure with its current strategy, as a result of the strategic significance of Island Heritageâ€™s insurance business, to the Company, and given the relative size of revenues generated by its insurance business, the Company modified its internal reporting process and the manner in which the business is managed and, as a result, the Company revised its segment structure, effective January 1, 2008. As a result of this process, the Company is now reporting its results to the chief operating decision maker based on two reporting segments: Reinsurance and Insurance.

Management views the operations and management of the Company as two separate reporting segments. We regularly review our financial results and assess our performance on the basis of our two reporting segments. Financial data relating to our segments is included in Note 21 â€śSegment Reportingâ€ť to our Consolidated Financial Statements (Item 8 below).

Substantially all of the reinsurance products we currently seek to write are in the form of treaty reinsurance contracts. When we write treaty reinsurance contracts, we do not evaluate separately each of the individual risks assumed under the contracts and are therefore largely dependent on the individual underwriting decisions made by the cedent. Accordingly, as part of our initial review and renewal process, we carefully review and analyze the cedentâ€™s risk management and underwriting practices in deciding whether to provide treaty reinsurance and in appropriately pricing the treaty.

Our contracts can be written on either a pro rata or on an excess of loss basis, generally with a per-event cap. With respect to pro rata reinsurance, we share the premiums as well as the losses and expenses in an agreed proportion with the cedent and typically provide a ceding commission to the client in order to pay for part of their business origination expenses. In the case of reinsurance written on an excess of loss basis, we receive the premium for the risk assumed and indemnify the cedent against all or a specified portion of losses and expenses in excess of a specified dollar or percentage amount.

The bulk of our portfolio of risks is assumed pursuant to traditional reinsurance contracts. We may also from time to time take underwriting risk by purchasing a catastrophe-linked bond, or via a transaction booked as an industry loss warranty (as described below under â€ś Property Catastrophe Reinsurance â€ť ) or an indemnity swap. An indemnity swap is an agreement which provides for the exchange between two parties of different portfolios of catastrophe exposure with similar expected loss characteristics (for example, U.S. earthquake exposure for Asian earthquake exposure). We believe our internal capital markets experience is useful in being able to analyze and evaluate underwriting risks independently from their legal form. All underwriting risks, regardless of the form in which they are entered into, are managed by the underwriting team as part of our overall risk portfolio.

Presently, we primarily focus on writing the following products:

Property Catastrophe Reinsurance. Property catastrophe reinsurance contracts are typically â€ś all risk â€ť in nature, meaning that they protect against losses from earthquakes and hurricanes, as well as other natural and man-made catastrophes such as tornados, fires, winter storms, and floods (where the contract specifically provides for coverage). Losses on these contracts typically stem from direct property damage and business interruption. To date, property catastrophe reinsurance has been our most significant product.

We write property catastrophe reinsurance primarily on an excess of loss basis. In the event of a loss, most contracts of this type require us to cover a subsequent event and generally provide for a premium to reinstate the coverage under the contract, which is referred to as a â€ś reinstatement premium â€ť. These contracts typically cover only specific regions or geographical areas, but may be on a worldwide basis.

We also provide industry loss warranty covers, which are triggered by loss and loss adjustment expenses incurred by the cedent and some pre-determined absolute level of industry-wide losses resulting from an insured event or by specific parameters of a defined event (such as a magnitude 8 earthquake or a category 4 hurricane).

Property Reinsurance. We also provide reinsurance on a pro rata share basis and per risk excess of loss basis. Per risk reinsurance protects insurance companies on their primary insurance risks on a single risk basis, for example, covering a single large building.

Short-tail Specialty and Casualty Reinsurance. We also provide short-tail specialty and casualty reinsurance for risks such as aviation, energy, personal accident and health, agribusiness, satellite, space, marine, workersâ€™ compensation catastrophe and casualty clash. Most short-tail specialty and casualty reinsurance is written with loss limitation provisions.

For the years ended December 31, 2008, 2007 and 2006, approximately 60%, 65% and 70%, respectively, of the risks we reinsured were related to natural catastrophes, such as hurricanes and earthquakes, in North America, the Caribbean and Europe, although we also have written a significant amount of catastrophe business in Japan and Australasia. Details of gross premiums written by line of business (including insurance) and by geographic area of risk insured are provided below:

(1)

Except as otherwise noted, each of these categories includes contracts that cover risks located primarily in the designated geographic area.
(2)

Gross premiums written related to the Insurance segment are included in the Caribbean geographic area, where our insurance business is based.
(3)

This geographic area includes contracts that cover risks primarily in two or more geographic zones.

Insurance Segment and Products

Island Heritage: Island Heritage is a property insurer domiciled in the Cayman Islands which is primarily in the business of insuring homes, condominiums and office buildings in the Caribbean region. The Company gained a controlling interest in Island Heritage in the third quarter of 2007, and as a result, the comparatives for the year ended December 31, 2007 set out in the table above include the results of Island Heritage for the six months ended December 31, 2007 only.

Marlborough : On November 18, 2008, the Company announced it had acquired 100% of the common shares of Marlborough, the managing agency for Lloydâ€™s Syndicate 1861 - a Lloydâ€™s syndicate underwriting a specialist portfolio of short-tail insurance and reinsurance, from the Berkshire Hathaway Group. The acquisition did not include the existing corporate Lloydâ€™s member or any liability for business written during or prior to 2008. The Company also incorporated a new subsidiary, Flagstone Corporate Name Limited, which has been admitted as a corporate member of Lloydâ€™s. Flagstone Corporate Name Limited is currently the sole capital provider for Lloydâ€™s Syndicate 1861 for fiscal year 2009 onwards. No business that incepted in 2008 for the benefit of the Flagstone group was written by Marlborough during the remainder of 2008 following its acquisition by the Company. These developments provide the Company with a Lloydâ€™s platform with access to both London business and business sourced globally from our network of offices.

Operations - Global Operating Platform

We have offices in Bermuda, Switzerland, India, the United Kingdom, Canada, Puerto Rico, Dubai, Cayman Islands, Cyprus, South Africa, Isle of Man, and Luxembourg. Most of our senior management, primarily underwriting and risk management functions are located in Switzerland, Bermuda and London and use the support services from the other offices, with lower operating costs or specialized functions, to deliver products and services to brokers and customers. This provides significant efficiencies in our operations and provides us with access to a large and highly qualified staff at a relatively low cost. We believe that we are positioned to perform and grow these functions outside of Switzerland, Bermuda and London to an extent that distinguishes us among global reinsurance companies of comparable capital size.

Flagstone Suisse is based in Martigny in the canton of Valais, Switzerland. Through this local presence, we are in a position to closely follow and respond effectively to the changing needs of the various European and Bermuda insurance markets. Flagstone Suisse is licensed by the Swiss Financial Market Supervisory Authority, or FINMA, in Switzerland. Flagstone Suisse is also a licensed permit company registered in Bermuda as a Class 4 insurer under the Bermuda Insurance Act operating through its Bermuda branch which complements our Swiss based underwriters with a separately staffed Bermuda underwriting platform.

Our research and development efforts, part of our catastrophe modeling and risk analysis team, and part of finance and accounting, are based in Hyderabad, India. Our office is located in the state of Andhra Pradesh, a region with many highly educated and talented financial analyst and software professionals, and the operating costs are substantially below those in Switzerland, Bermuda and Halifax (Canada).

In London, England, we have Marlborough, the managing agency for Lloydâ€™s Syndicate 1861 - a Lloydâ€™s syndicate underwriting a specialist portfolio of short-tail insurance and reinsurance and an international reinsurance marketing operation promoting Flagstone to international and multinational clients. In addition, our U.K. operations, through Flagstone Representatives Limited, our London based market intermediary regulated by the Financial Services Authority (â€śFSAâ€ť), work alongside our underwriters to develop global business opportunities and maintain relationships with existing clients.

In Halifax, Nova Scotia, Canada, we have a computer data center where we run support services such as accounting, claims, application support, administration, risk modeling, proprietary systems development and high performance computing. Halifax has a concentration of university graduates with professional backgrounds and credentials in such areas as finance, information technology and science which are appropriate for our operational support functions. In general, the cost of employing a highly skilled work force in Halifax is lower than in Bermuda. In addition, Halifax is in the same time zone as Bermuda, which facilitates communications between our offices.

Our Puerto Rico office, established in 2007 and licensed with the Office of the Commissioner of Insurance of Puerto Rico, provides an underwriting platform targeting the Caribbean and Latin American regions, primarily on behalf of Flagstone Suisse.

In Dubai, we have established and licensed a reinsurance intermediary operation with the Dubai Financial Services Authority to provide marketing and underwriting support for the Middle East and North Africa on behalf of Flagstone Suisse.

In the Cayman Islands, we write insurance business generated through Island Heritage, which primarily is in the business of insuring homes, condominiums and office buildings in the Caribbean region.

In the Republic of Cyprus, we write specialty property and casualty reinsurance through Flagstone Alliance.

In South Africa, we write multiple lines of reinsurance through Flagstone Africa.

In Luxembourg, we manage our investment portfolio within Flagstone Capital Management Luxembourg S.A. SICAF FIS (â€śFCMLâ€ť). FCML is a fixed capital investment company qualifying as a specialized investment fund under the Luxembourg law of February 13, 2007 and may be constituted with multiple sub funds each corresponding to a distinct part of the assets and liabilities of the investment company.

We believe our operating platform affords us the capability and flexibility to deploy our capital and expertise strategically, efficiently and tactically throughout the global markets. For example, compared to our competitors, we believe these capabilities allow us to process new business submissions quickly and thoroughly, to review relatively more risks in the search for attractive opportunities and to explore new markets where the accumulation and analysis of data is a time-consuming activity.

Ratings

Financial strength ratings have become an increasingly important factor in establishing the competitive position of insurance and reinsurance companies. Rating organizations continually review the financial positions of insurers and reinsurers, including Flagstone. The following are the current financial strength ratings from internationally recognized rating agencies for Flagstone Suisse:

Our ability to underwrite business is dependent upon the quality of our claims paying and financial strength ratings as evaluated by independent rating agencies. In the event that we are downgraded by any of the agencies below where our ratings currently are, we believe our ability to write business would be adversely affected. In the normal course of business, we evaluate our capital needs to support the volume of business written in order to maintain our claims paying and financial strength ratings. We regularly provide financial information to rating agencies to both maintain and enhance existing ratings.

These ratings are not evaluations directed to investors in our securities or a recommendation to buy, sell or hold our securities. Our ratings may be revised or revoked at the sole discretion of the rating agencies.

Syndicate 1 861 at Lloydâ€™s of London: All Lloydâ€™s syndicates, including Syndicate 1861, benefit from Lloydâ€™s central resources, including the Lloydâ€™s brand, its network of global licenses and the â€śCentral Fundâ€ť. The Central Fund is available at the discretion of the Council of Lloydâ€™s to meet any valid claim that cannot be met by the resources of any member. As all Lloydâ€™s policies are ultimately backed by this common security, a single market rating can be applied. Lloydâ€™s as a market is rated as follows:

Underwriting and Risk Management

We view underwriting and risk management as an integrated process. We commence underwriting a risk only after we have an initial understanding of how its addition to our existing portfolio would impact our total single event loss potential by risk zone. After completing our detailed underwriting analysis, and before we provide an indication of terms and price, we ensure that we understand the change this risk will make in the overall risk of our insurance portfolio. We constantly review our global exposures as new opportunities are shown to us, as we bind new business, and as policies mature to ensure that we are continuously aware of our overall underwriting risk. A principal focus of Flagstone is to develop and effectively utilize sophisticated computer models and other analytical tools to assess the risks that we underwrite and to optimize our portfolio of underwriting and investment risks.

Underwriting

Our principal underwriting objective is to create a balanced portfolio of risks, diversified by risk zone. Underwriting and pricing controls are exercised through our chief underwriting officers and our chief actuary. The underwriting team is supported by additional underwriters, catastrophe risk analysts, an actuarial team, a catastrophe modeling and research team and a full complement of underwriting administrative support positions.

CEO BACKGROUND

OUR DIRECTORS

Directors

The table below sets forth the names, ages and positions of the current directors of the Company:

Name

Age

Positions

Mark J. Byrne

47

Executive Chairman of the Board of Directors
David A. Brown

51

Chief Executive Officer, Deputy Chairman and Director
Gary Black

63

Director
Stephen Coley

64

Director
Thomas Dickson

46

Director
Stewart Gross

49

Director
E. Daniel James

44

Director
Anthony P. Latham

58

Director
Dr. Anthony Knap

59

Director
Jan Spiering

57

Director
Wray T. Thorn

37

Director
Peter F. Watson

66

Director

MANAGEMENT DISCUSSION FROM LATEST 10K

The following is a discussion and analysis of our financial condition as at December 31, 2008 and 2007 and our results of operations for the years ended December 31, 2008, 2007 and 2006. All amounts in the following tables are expressed in thousands of U.S. dollars, except share amounts, per share amounts and percentages. This discussion should be read in conjunction with our audited consolidated financial statements and related notes included in Item 8 of this Form 10-K. Some of the information contained in this discussion and analysis is included elsewhere in this document, including information with respect to our plans and strategy for our business, and includes forward-looking statements that involve risks and uncertainties. Please see the â€śCautionary Statement Regarding Forward-Looking Statementsâ€ť for more information. You should review Item 1A, â€śRisk Factorsâ€ť for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements.

Executive Overview

We are a global reinsurance and insurance company. The Company is currently organized into two business segments: Reinsurance and Insurance. Through our Reinsurance segment, we write primarily property, property catastrophe and short-tail specialty and casualty reinsurance. Through our Insurance segment, we primarily write property insurance for homes, condominiums and office buildings in the Caribbean region. In addition, beginning in 2009 as a result of our recent acquisition of Marlborough, the managing agency for Lloyd's Syndicate 1861, the majority of the business written through Lloydâ€™s Syndicate 1861 will also be included in the Insurance segment.

We were formed by Haverford, a company controlled and capitalized by Mark Byrne, the Executive Chairman of our Board of Directors, and David Brown, our Chief Executive Officer, and we commenced operations in December 2005. On March 30, 2007, the Companyâ€™s common shares began trading on the New York Stock Exchange. The Company completed the IPO of 13.0 million of its common shares on April 4, 2007 resulting in gross proceeds to the Company of $175.5 million ($159.3 million net of expenses). In connection with this IPO, the Company filed a Registration Statement on Form S-1 (Registration No. 333-138182) with the Securities and Exchange Commission (the â€śSECâ€ť) on March 30, 2007. On April 30, 2007, the underwriters of the IPO exercised their option to purchase an additional 750,000 common shares of the Company at the public offering price less underwriting discounts and commissions resulting in gross proceeds of $10.1 million ($9.4 million net of expenses).

The various components of our operating model are unified through our centralized management in Hamilton, Bermuda and Martigny, Switzerland and integrated through our use of advanced technology. Flagstone Suisse is based in Martigny in the canton of Valais, Switzerland. We believe that for many lines of business we can be more effective in marketing and attracting continental European business in Switzerland than in Bermuda, and that for many clients, a Swiss counterparty would be preferred. Through this local presence, we are in a position to closely follow and respond effectively to the changing needs of the various European insurance markets. Flagstone Suisse is licensed by the FINMA, in Switzerland. Flagstone Suisse is also licensed as a permit company registered in Bermuda and is registered as a Class 4 insurer under the Bermuda Insurance Act and complements our Swiss based underwriters with a separately staffed Bermuda underwriting platform. During 2008, we continued to expand our global operating platform through the acquisition of 65% of the outstanding common shares of Flagstone Africa, formerly known as Imperial Re, a South African reinsurer who primarily writes multiple lines of reinsurance in sub-Saharan Africa. Also during 2008, the Company acquired 100% of the outstanding common shares of Flagstone Alliance, formerly known as Alliance Re, a Cypriot reinsurer writing multiple lines of business in Europe, Asia, and the Middle East & North Africa region. On November 18, 2008, the Company acquired 100% of the common shares of Marlborough the managing agency for Lloydâ€™s Syndicate 1861 - a Lloydâ€™s syndicate underwriting a specialist portfolio of short-tail insurance and reinsurance. The Marlborough acquisition provides the Company with a Lloydâ€™s platform with access to both London business and that sourced globally from our network of offices. For further information on these acquisitions refer to Note 3 â€śAcquisitionsâ€ť in Item 8 - Financial Statements and Supplementary Data of this Form 10-K. Our research and development efforts and part of our catastrophe modeling and risk analysis team, and part of finance and accounting are based in Hyderabad, India, and our international reinsurance marketing operations are conducted from London, England. Our computer data center is in our Halifax, Canada office, where we also run support services such as accounting, claims, application support, administration, risk modeling, proprietary systems development and high performance computing. The result is an operating platform which provides significant efficiencies in our operations and access to a large and highly qualified staff at a relatively low cost.

Because we have a limited operating history, period to period comparisons of our results of operations are limited and may not be meaningful in the near future. Our financial statements are prepared in accordance with U.S. GAAP and our fiscal year ends on December 31. Since a substantial portion of the reinsurance we write provides protection from damages relating to natural and man-made catastrophes, our results depend to a large extent on the frequency and severity of such catastrophic events, and the specific insurance coverages we offer to clients affected by these events. This may result in volatility in our results of operations and financial condition. In addition, the amount of premiums written with respect to any particular line of business may vary from quarter to quarter and year to year as a result of changes in market conditions.

We measure our financial success through long term growth in diluted book value per share plus accumulated dividends measured over intervals of three years, which we believe is the most appropriate measure of the performance of the Company, a measure that focuses on the return provided to the Companyâ€™s common shareholders. Diluted book value per share is obtained by dividing shareholdersâ€™ equity by the number of common shares and common share equivalents outstanding.

We derive our revenues primarily from net premiums earned from the reinsurance and insurance policies we write, net of any retrocessional or reinsurance coverage purchased, net investment income from our investment portfolio, and fees for services provided. Premiums are generally a function of the number and type of contracts we write, as well as prevailing market prices. Premiums are normally due in installments and earned over the contract term, which ordinarily is twelve months.

Income from our investment portfolio is primarily comprised of interest on fixed maturity, short term investments and cash and cash equivalents, dividends and proportionate share of net income for those investments accounted for on an equity basis, net realized and unrealized gains (losses) on our investment portfolio including our derivative positions, net of investment expenses.

Our expenses consist primarily of the following types: loss and loss adjustment expenses incurred on the policies of reinsurance and insurance that we sell; acquisition costs which typically represent a percentage of the premiums that we write; general and administrative expenses which primarily consist of salaries, benefits and related costs, including costs associated with awards under our PSU and RSU Plans, and other general operating expenses; interest expenses related to our debt obligations; and minority interest, which represents the interest of external parties with respect to the net income of Mont Fort, Island Heritage, and Flagstone Africa. We are also subject to taxes in certain jurisdictions in which we operate; however, since the majority of our income to date has been earned in Bermuda, a non-taxable jurisdiction, the tax impact on our operations has historically been minimal. As a result of the merger between Flagstone Reinsurance Limited and Flagstone Suisse, we expect our tax expense to increase to approximate our effective Swiss Federal tax rate of approximately 8% on the portion of underwriting profits, if any, generated by Flagstone Suisse, excluding the underwriting profits generated in Bermuda through the Flagstone Suisse branch office.

The Company holds a controlling interest in Island Heritage, whose primary business is insurance. As a result of the strategic significance of the insurance business to the Company, and given the relative size of revenues generated by the insurance business, the Company modified its internal reporting process and the manner in which the business is managed and as a result the Company revised its segment structure, effective January 1, 2008, to include a new Insurance segment. As a result of this process the Company is now reporting its results to the chief operating decision maker based on two reporting segments: Reinsurance and Insurance. The 2007 comparative information below reflects our current segment structure. As the Company did not undertake any insurance business prior to its acquisition of Island Heritage in the third quarter of 2007, there is no 2006 comparative information for the Insurance segment. The Company regularly reviews its financial results and assesses performance on the basis of these two operating segments.

Those segments are more fully described as follows:

Reinsurance

Our Reinsurance segment has three main units:

(1)

Property Catastrophe Reinsurance. Property catastrophe reinsurance contracts are typically â€śall riskâ€ť in nature, meaning that they protect against losses from earthquakes and hurricanes, as well as other natural and man-made catastrophes such as tornados, wind, fires, winter storms, and floods (where the contract specifically provides for coverage). Losses on these contracts typically stem from direct property damage and business interruption. To date, property catastrophe reinsurance has been our most important product. We write property catastrophe reinsurance primarily on an excess of loss basis. In the event of a loss, most contracts of this type require us to cover a subsequent event and generally provide for a premium to reinstate the coverage under the contract, which is referred to as a â€śreinstatement premiumâ€ť. These contracts typically cover only specific regions or geographical areas, but may be on a worldwide basis.

(2)

Property Reinsurance. We also provide reinsurance on a pro rata share basis and per risk excess of loss basis. Per risk reinsurance protects insurance companies on their primary insurance risks on a single risk basis, for example, covering a single large building. All property per risk and pro rata business is written with loss limitation provisions, such as per occurrence or per event caps, which serve to limit exposure to catastrophic events.

(3)

Short-tail Specialty and Casualty Reinsurance. We also provide short-tail specialty and casualty reinsurance for risks such as aviation, energy, accident and health, satellite, marine and workersâ€™ compensation catastrophe. Most short-tail specialty and casualty reinsurance is written with loss limitation provisions. During 2009, we expect to continue increasing our specialty writings based on our assessment of the market environment.

On September 30, 2008, the Company completed the restructuring of its global reinsurance operations by merging its two wholly-owned subsidiaries, Flagstone Reinsurance Limited and Flagstone Suisse into one succeeding entity, Flagstone Suisse with its existing Bermuda branch. The merger consolidated the Companyâ€™s underwriting capital into one main operating entity, maximizing capital efficiency and creditworthiness, while still offering a choice of either Bermuda or Swiss underwriting access. Because both companies were wholly-owned subsidiaries of the Company, the merger did not result in any changes to prior periods. The change in corporate structure does not result in any change of management or corporate control, or any changes to the Board of Directors.

Insurance

The Company has established a new Insurance segment during the year ended December 31, 2008, which included insurance business generated through Island Heritage, a property insurer based in the Cayman Islands which is primarily in the business of insuring homes, condominiums and office buildings in the Caribbean region. The Company gained controlling interest in Island Heritage on July 3, 2007, and as a result, the comparatives for the year ended December 31, 2007 include the results of Island Heritage for the six months ended December 31, 2007 only. The Company did not undertake any insurance business prior to its acquisition of Island Heritage in the third quarter of 2007, and therefore there are no comparatives for the year ended December 31, 2006.

Critical Accounting Estimates

It is important to understand our accounting policies in order to understand our financial position and results of operations. Our audited consolidated financial statements contain certain amounts that are inherently subjective in nature and have required management to make assumptions and best estimates to determine the reported values. If events or other factors, including those described in Item 1A, â€śRisk Factors,â€ť cause actual events or results to differ materially from managementâ€™s underlying assumptions or estimates, there could be a material adverse effect on our results of operations, financial condition and liquidity.

The following are the accounting estimates that, in managementâ€™s judgment, are critical due to the judgments, assumptions and uncertainties underlying the application of those policies and the potential for results to differ from managementâ€™s assumptions.

Loss and Loss Adjustment Expense Reserves

Because a significant amount of time can lapse between the assumption of a risk, the occurrence of a loss event, the reporting of the event to an insurance company (the primary company or the cedent), the subsequent reporting to the reinsurance company (the reinsurer) and the ultimate payment of the claim by the reinsurer, our liability for loss reserves is based largely upon estimates. We believe that the most significant accounting judgment we make is our estimate of loss reserves.

Under U.S. GAAP, we are not permitted to establish loss reserves, which include case and IBNR reserves, until the occurrence of an event which may give rise to a claim. As a result, only loss reserves applicable to losses incurred up to the reporting date are established, with no allowance for the establishment of loss reserves to account for expected future losses. Claims arising from future catastrophic events can be expected to require the establishment of substantial loss reserves from time to time.

Our loss reserve estimates do not represent an exact calculation of liability. Rather, they represent estimates of our expectations of the ultimate settlement and administration costs of claims incurred. These estimates are based upon actuarial and statistical projections and on our assessment of currently available data, predictions of future developments and estimates of future trends in claims severity and frequency and other variable factors such as inflation. Establishing an appropriate level of our loss reserve estimates is an inherently uncertain process. It is likely that the ultimate liability will be greater or less than these estimates and that, at times, this variance will be material.

For a breakdown of reserves for losses and loss adjustment expenses refer to Note 7 â€śLoss and Loss Adjustment Expense Reservesâ€ť and Note 8 â€śReinsuranceâ€ť in Item 8, â€śFinancial Statements and Supplementary Dataâ€ť of this Annual Report on Form 10-K.

As we are primarily a broker market reinsurer, reserving for our business can involve added uncertainty because we depend on information from ceding companies. There is a time lag inherent in reporting information from the primary insurer to us and ceding companies have differing reserving practices. The information we receive varies by cedent and broker and may include paid losses and estimated case reserves. We may also receive an estimated provision for IBNR reserves, especially when the cedent is providing data in support of a request for collateral for loss reserves ceded. The information received from ceding companies is typically in the form of bordereaux, which are reports providing premium or loss data with respect to identified risks, broker notifications of loss and/or discussions with ceding companies or their brokers. This information can be received on a monthly, quarterly or transactional basis. As a reinsurer, our reserve estimates may be inherently less reliable than the reserve estimates of our primary insurer cedents.

Because a significant component of our business is generally characterized by loss events of low frequency and high severity, reporting of claims in general tends to be prompt (as compared to reporting of claims for casualty or other â€ślong-tailâ€ť lines of business). However, the timing of claims reporting can vary depending on various factors, including: the nature of the event (e.g., hurricane, earthquake and hail); the quality of the cedentâ€™s claims management and reserving practices; the geographic area involved; and whether the claims arise under reinsurance or insurance contracts for primary companies, or reinsurance of other reinsurance companies. Because the events from which catastrophe claims arise are typically prominent, public occurrences, we are often able to use independent reports of such events to augment our loss reserve estimation process. Because of the degree of reliance that we place on ceding companies for claims reporting, the associated time lag, the low frequency and high severity nature of the business we underwrite and the varying reserving practices among ceding companies, our reserve estimates are highly dependent on managementâ€™s judgment and are therefore subject to significant variability from one quarter to another. During the loss settlement period, additional facts regarding individual claims and trends may become known, and current laws and case law may change.

For reinsurance written on an excess of loss basis, which represents approximately 65.0%, 68.0% and 80.1% of the premiums we wrote for the years ended December 31, 2008, 2007 and 2006, respectively, our exposure is limited by the fact that most treaties have a defined limit of liability arising from a single loss event. Once the limit has been reached, we have no further exposure to additional losses from that treaty for the same loss event. For reinsurance on a pro rata basis, we typically have event caps so these liabilities are contained.

The Companyâ€™s actuarial group performs a quarterly loss reserve analysis. This analysis incorporates specific exposures, loss payment and reporting patterns and other relevant factors. This process involves the segregation of risks between catastrophic and non-catastrophic risks to ensure appropriate treatment.

For our property catastrophe policies which comprise 58.5%, 65.6% and 72.4% of our total gross premiums written for the years ended December 31, 2008, 2007 and 2006, respectively, and other catastrophe policies, we initially establish our loss reserves based on loss payments and case reserves reported by ceding companies. We then add to these case reserves our estimates for IBNR. To establish our IBNR estimates, in addition to the loss information and estimates communicated by cedents, we use industry information, knowledge of the business written by us, managementâ€™s judgment and general market trends observed from our underwriting activities.

When a catastrophic event occurs, we first determine which treaties may be affected using our zonal monitoring of exposures. We contact the respective brokers and ceding companies involved with those treaties, to determine their estimate of involvement and the extent to which the reinsurance program is affected. We may also use our computer-based vendor and proprietary modeling systems to measure and estimate loss exposure under the actual event scenario, if available. Although the loss modeling systems assist with the analysis of the underlying loss, and provide us with information and the ability to perform an enhanced analysis, the estimation of claims resulting from catastrophic events is inherently difficult because of the variability and uncertainty of property and other catastrophe claims and the unique characteristics of each loss.

For non-catastrophe business, we utilize a variety of standard actuarial methods in our analysis. The selections from these various methods are based on the loss development characteristics of the specific line of business and specific contracts. The actuarial methods we use to perform our quarterly contract by contract loss reserve analysis include:

â—Ź

Paid Loss Development Method. We estimate ultimate losses by calculating past paid loss development factors and applying them to exposure periods with further expected paid loss development. The paid loss development method assumes that losses are paid at a consistent rate. It provides an objective test of reported loss projections because paid losses contain no reserve estimates. For many coverages, claim payments are made very slowly and it may take years for claims to be fully reported and settled. This method is a key input into the Bornheutter-Ferguson paid loss method discussed below.

â—Ź

Reported Loss Development Method. We estimate ultimate losses by calculating past reported loss development factors and applying them to exposure periods with further expected reported loss development. Since reported losses include payments and case reserves, changes in both of these amounts are incorporated in this method. This approach provides a larger volume of data to estimate ultimate losses than paid loss methods. Thus, reported loss patterns may be less varied than paid loss patterns, especially for coverages that have historically been paid out over a long period of time but for which claims are reported relatively early and case loss reserve estimates established. This method is a key input into the Bornheutter-Ferguson reported loss method discussed below.

â—Ź

Expected Loss Ratio Method. To estimate ultimate losses under the expected loss ratio method, we multiply earned premiums by an expected loss ratio. The expected loss ratio is selected utilizing industry data, historical company data and professional judgment. The Company uses this method for lines of business and contracts where there are no historical losses or where past loss experience is not credible.

â—Ź

Bornheutter-Ferguson Paid Loss Method. The Bornheutter-Ferguson paid loss method is a combination of the paid loss development method and the expected loss ratio method. The amount of losses yet to be paid is based upon the expected loss ratios. These expected loss ratios are modified to the extent paid losses to date differ from what would have been expected to have been paid based upon the selected paid loss development pattern. This method avoids some of the distortions that could result from a large development factor being applied to a small base of paid losses to calculate ultimate losses. This method will react slowly if actual loss ratios develop differently because of major changes in rate levels, retentions or deductibles, the forms and conditions of reinsurance coverage, the types of risks covered or a variety of other changes.

â—Ź

Bornheutter-Ferguson Reported Loss Method. The Bornheutter-Ferguson reported loss method is similar to the Bornheutter-Ferguson paid loss method with the exception that it uses reported losses and reported loss development factors. The Company uses this method for lines of business and contracts where there are limited historical paid and reported losses.

Initially selected expected loss ratios are used while the exposure is earning. We assign payment and reporting patterns for attritional business to use with paid development, incurred development, and paid and reported Bornheutter-Ferguson methods. We maintain an expected loss ratio through the exposure earning period followed by selections of Bornheutter-Ferguson paid and reported during intermediate reporting periods. Later, through the development, we revert from Bornheutter-Ferguson paid and reported to paid and reported development methods to fully reflect account experience. This entails a reasonable evolution from initial expected loss ratios to full account experience through a tempering phase of Bornheutter-Ferguson weightings. We maintain a conservative bias toward the selection of Bornheutter-Ferguson paid and reported methods on accounts with losses paid or reported earlier while holding expected loss ratios on loss free accounts where no paid or reported losses have yet occurred early in the accountâ€™s maturation.

We reaffirm the validity of the assumptions we use in the reserving process on a quarterly basis during our internal review process. During this process, the Companyâ€™s actuaries verify that the assumptions continue to form a sound basis for projection of future liabilities.

Our critical underlying assumptions are:

(i) the cedentâ€™s business practices will proceed as in the past with no material changes either in submission of accounts or cash flow receipts;

(ii) case reserve reporting practices, particularly the methodologies used to establish and report case reserves, are unchanged from historical practices;

(iv) historical levels of claim inflation can be projected into the future;

(v) in cases where benchmarks are used, they are derived from the experience of similar business; and

(vi) we form a credible initial expectation of the ultimate loss ratios through a review of pricing information supplemented by qualitative information on market events.

All of our critical assumptions can be thought of as key assumptions in the sense that they can have a material impact on the adequacy of our reserves. In general, the various actuarial techniques we use assume that loss reporting and payment patterns in the future can be estimated from past experience. To the extent that any of the above assumptions is not valid, future payment and reporting patterns could differ from historical experience. In practice it is difficult to be precise on the effect of each assumption. However, due to a greater potential for estimation error, and thus greater volatility, our reserves may be more sensitive to the effects of deviations from assumptions (iv), (v) and (vi) than the other assumptions.

Our reserving methodology, as discussed above, uses a loss reserving model that calculates a point estimate for the Companyâ€™s ultimate losses, as opposed to a methodology that develops a range of estimates. The Company then uses this point estimate, deducting cumulative paid claims and current case reserves, to record its estimate of IBNR. The Company employs sensitivity analysis in selecting our point estimate, which involves varying industry loss estimates for catastrophe events and estimated loss ratio for non-catastrophe business.

Our reserve estimates for reported catastrophe losses are based upon industry loss estimates and our modeled loss scenarios. Because any catastrophe event loss reserve estimate is simply an insurerâ€™s estimate of its ultimate liability, and because there are numerous factors which affect reserves but cannot be determined with certainty in advance, our ultimate payments will vary, perhaps materially, from our initial estimate of reserves. Therefore, because of these inherent uncertainties, we have developed a reserving philosophy which attempts to incorporate prudent assumptions and estimates in making our loss selection based on both the potential for adverse development and historical experience among industry participants. Our reserving philosophy does not include an explicit adjustment to our point estimate of ultimate losses. There may be instances in the future in which it would be beneficial to develop a range of estimates, but at present, due to our short operating history, we have not found it necessary to do so.

For our non-catastrophe business, the key factors used to arrive at our best estimate of loss and loss adjustment expense reserves are the expected loss ratios, rate of loss cost inflation, selection of benchmarks and reported and paid loss emergence patterns. Our reporting patterns and expected loss ratios were based on either benchmarks or historical reporting patterns. The benchmarks selected are those that we believe are most similar to our underwriting business. There were no material changes in any of these key factors during the year ended December 31, 2008.

Although we believe that we are prudent in our assumptions and methodologies, we cannot be certain that our ultimate payments will not vary, perhaps materially, from the estimates we have made. If we determine that adjustments to an earlier estimate are appropriate, such adjustments are recorded in the quarter in which they are identified. The establishment of new reserves, or the adjustment of reserves for reported claims, could result in significant upward or downward changes to our financial condition or results of operations in any particular period. We regularly review and update these estimates using the most current information available to us. Our estimates are reviewed annually by an independent actuary in order to provide additional insight into the reasonableness of our loss reserves.

During the year ended December 31, 2008, the significant losses on our catastrophe business were as follows: Hurricane Ike ($158.4 million), Hurricane Gustav ($14.5 million), Chinese winter storms ($18.2 million) and the U.S. Memorial Day Weekend storms ($11.1 million). During the year ended December 31, 2007, the significant losses on our catastrophe business were as follows: United Kingdom floods in June and July ($38.0 million); European Windstorm Kyrill ($32.4 million); New South Wales (Australia) floods ($18.5 million); three satellite losses during 2007 ($13.8 million); and the Sydney Hailstorm ($11.4 million). Given the benign catastrophe activity during the year ended December 31, 2006, the losses incurred on catastrophe business were approximately $12.4 million. Because we expect a small volume of large claims, we believe the variance of our catastrophe related loss ratio could be relatively wide. Claims from catastrophic events could reduce our earnings and cause substantial volatility in our results of operations for any fiscal quarter or year which could adversely affect our financial condition and liquidity position.

A significant component of our loss ratio relates to non-catastrophe business for the years ended December 31, 2008, 2007 and 2006. As we commonly write net lines of non-catastrophe business exceeding $10.0 million, we expect that the ultimate loss ratio for non-catastrophe business can vary significantly from our initial loss ratios. Thus, a 10% increase or decrease in loss ratios for non-catastrophe business is likely to occur and, for the years ended December 31, 2008, 2007 and 2006, this would have resulted in an approximate increase or decrease in our net income or shareholdersâ€™ equity of approximately $21.4 million, $6.3 million and $1.4 million, respectively.

Premiums and Acquisition Costs

We recognize premiums as revenue ratably over the terms of the related contracts and policies. Our gross premiums written are based on policy and contract terms and include estimates based on information received from both insured and ceding companies. The information received is typically in the form of bordereaux, broker notifications and/or discussions with ceding companies or their brokers. This information can be received on a monthly, quarterly or transactional basis and normally includes estimates of gross premiums written (including adjustment premiums and reinstatement premiums), net premiums earned, acquisition costs and ceding commissions. Adjustment premiums are premiums due to either party when the contractâ€™s subject premium is adjusted at expiration and is recorded in subsequent periods. Reinstatement premiums are premiums charged for the restoration of a reinsurance limit of an excess of loss contract to its full amount after payment of losses as a result of an occurrence.

We write treaty and facultative reinsurance on either a non-proportional (also referred to as excess of loss) basis or a proportional (also referred to as pro rata) basis. Insurance premiums written are recorded in accordance with the terms of the underlying policies.

We book premiums on excess of loss contracts in accordance with the contract terms and earn them over the contract period. Since premiums for our excess of loss contracts are usually established with some certainty at the outset of the contract and the reporting lag for such premiums is minimal, estimates for premiums written for these contracts are usually not significant. The minimum and deposit premiums on excess of loss contracts are usually set forth in the language of the contract and are used to record premiums on these contracts. Actual premiums are determined in subsequent periods based on actual exposures and any adjustments are recorded in the period in which they are identified.

MANAGEMENT DISCUSSION FOR LATEST QUARTER

The following is a discussion and analysis of our financial condition as at September 30, 2009 and December 31, 2008, and our results of operations for the three and nine months ended September 30, 2009 and 2008. This discussion should be read in conjunction with our unaudited condensed consolidated financial statements and related notes included in Part 1, Item 1 of this Form 10-Q and with â€śManagementâ€™s Discussion and Analysis of Financial Condition and Results of Operationsâ€ť, and the audited consolidated financial statements and notes thereto, presented under Item 7 and Item 8, respectively, of the Companyâ€™s Annual Report on Form 10-K for the year ended December 31, 2008. Some of the information contained in this discussion and analysis is included elsewhere in this document, including information with respect to our plans and strategy for our business, and includes forward-looking statements that involve risks and uncertainties. Please see the â€śCautionary Statement Regarding Forward-Looking Statementsâ€ť for more information. You should review Item 1A, â€śRisk Factorsâ€ť contained in our Form 10-K, filed with the SEC on March 13, 2009, for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements.

We are a global reinsurance and insurance company. Effective January 1, 2009, as a result of our acquisition of Marlborough, the managing agency for Lloydâ€™s Syndicate 1861, management views the Company as being organized into three business segments: Reinsurance, Lloydâ€™s and Insurance. Through our Reinsurance segment, we write primarily property, property catastrophe and short-tail specialty and casualty reinsurance. Through our Lloydâ€™s segment, we write primarily property and short-tail specialty and casualty reinsurance focused on the energy, hull and cargo, marine liability, engineering and aviation business sectors. Through our Insurance segment, we primarily write property insurance for homes, condominiums and office buildings in the Caribbean region.

Because we have a limited operating history, period to period comparisons of our results of operations are limited and may not be meaningful in the near future. Our financial statements are prepared in accordance with U.S. GAAP and our fiscal year ends on December 31. Since a substantial portion of the reinsurance we write provides protection from damages relating to natural and man-made catastrophes, our results depend to a large extent on the frequency and severity of such catastrophic events, and the specific insurance coverages we offer to clients affected by these events. This may result in volatility in our results of operations and financial condition. In addition, the amount of premiums written with respect to any particular line of business may vary from quarter to quarter and year to year as a result of changes in market conditions.

We measure our financial success through long term growth in diluted book value per share plus accumulated dividends measured over intervals of three years, which we believe is the most appropriate measure of the performance of the Company, a measure that focuses on the return provided to the Companyâ€™s common shareholders. Diluted book value per share is obtained by dividing Flagstoneâ€™s shareholdersâ€™ equity by the number of common shares and common share equivalents outstanding.

We derive our revenues primarily from net premiums earned from the reinsurance and insurance policies we write, net of any retrocessional or reinsurance coverage purchased, net investment income from our investment portfolio, and fees for services provided. Premiums are generally a function of the number and type of contracts we write, as well as prevailing market prices. Premiums are normally due in installments and earned over the contract term, which ordinarily is twelve months.

Our expenses consist primarily of the following types: loss and loss adjustment expenses incurred on the policies of reinsurance and insurance that we sell; acquisition costs which typically represent a percentage of the premiums that we write; general and administrative expenses which primarily consist of salaries, benefits and related costs, including costs associated with awards under our PSU and RSU Plans, and other general operating expenses; interest expenses related to our debt obligations; and noncontrolling interest, which represents the interest of external parties with respect to the net income of Mont Fort, Island Heritage, and Flagstone Africa. We are also subject to taxes in certain jurisdictions in which we operate; however, since the majority of our income to date has been earned in Bermuda, a non-taxable jurisdiction, the tax impact on our operations has historically been minimal. As a result of the merger between Flagstone Reinsurance Limited and Flagstone Suisse on September 30, 2008, we expect our tax expense to increase to approximate our effective Swiss Federal tax rate of approximately 8% on the portion of underwriting profits, if any, generated by Flagstone Suisse, excluding the underwriting profits generated in Bermuda through the Flagstone Suisse branch office.

The Company reports its results to the chief operating decision maker based on three reporting segments: Reinsurance, Lloydâ€™s and Insurance. The Company regularly reviews its financial results and assesses performance on the basis of these three operating segments.

Those segments are more fully described as follows:

Reinsurance

Our Reinsurance segment has three main units:

(1)

Property Catastrophe Reinsurance. Property catastrophe reinsurance contracts are typically â€śall riskâ€ť in nature, meaning that they protect against losses from earthquakes and hurricanes, as well as other natural and man-made catastrophes such as tornados, wind, fires, winter storms, and floods (where the contract specifically provides for coverage). Losses on these contracts typically stem from direct property damage and business interruption. To date, property catastrophe reinsurance has been our most important product. We write property catastrophe reinsurance primarily on an excess of loss basis. In the event of a loss, most contracts of this type require us to cover a subsequent event and generally provide for a premium to reinstate the coverage under the contract, which is referred to as a â€śreinstatement premiumâ€ť. These contracts typically cover only specific regions or geographical areas, but may be on a worldwide basis.

(2)

Property Reinsurance. We also provide reinsurance on a pro rata share basis and per risk excess of loss basis. Per risk reinsurance protects insurance companies on their primary insurance risks on a single risk basis, for example, covering a single large building. Generally, our property per risk and pro rata business is written with loss limitation provisions, such as per occurrence or per event caps, which serve to limit exposure to catastrophic events.

(3)

Short-tail Specialty and Casualty Reinsurance. We also provide short-tail specialty and casualty reinsurance for risks such as aviation, energy, accident and health, satellite, marine and workersâ€™ compensation catastrophe. Generally, our short-tail specialty and casualty reinsurance is written with loss limitation provisions.

Lloydâ€™s

Our Lloydâ€™s segment includes the business generated through the Lloydâ€™s Syndicate 1861 and Marlborough. Syndicate 1861 primarily provides property and short-tail specialty and casualty reinsurance for risks such as energy, hull and cargo, marine liability, engineering and aviation.

Insurance

Our Insurance segment includes insurance business generated through Island Heritage. Island Heritage is a property insurer based in the Cayman Islands which is primarily in the business of insuring homes, condominiums and office buildings in the Caribbean region.

Critical Accounting Policies

Critical accounting policies at September 30, 2009 have not changed compared to December 31, 2008. The Companyâ€™s critical accounting policies are discussed in â€śManagementâ€™s Discussion and Analysis of Financial Condition and Results of Operationsâ€ť in Item 7 of the Companyâ€™s Annual Report on Form 10-K for the year ended December 31, 2008.

It is important to understand our accounting policies in order to understand our financial position and results of operations. Our unaudited condensed consolidated financial statements contain certain amounts that are inherently subjective in nature and have required management to make assumptions and best estimates to determine the reported values. If events or other factors, including those described in Item 1A, â€śRisk Factors,â€ť of our Form 10-K, cause actual events or results to differ materially from managementâ€™s underlying assumptions or estimates, there could be a material adverse effect on our results of operations, financial condition and liquidity.

New Accounting Pronouncements

Adoption of new accounting pronouncements

On September 15, 2009, the Company adopted FASB ASC Topic 105, â€śGenerally Accepted Accounting Principlesâ€ť (â€śASC 105â€ť or â€śThe Codificationâ€ť). ASC 105 is a replacement to FASB Statement No. 162, â€śThe Hierarchy of Generally Accepted Accounting Principles,â€ť (â€śSFAS 162â€ť) which became effective on November 13, 2008, and identified the sources of accounting principles and the framework for selecting the principles used in preparing financial statements in conformity with U.S. GAAP. It also arranged these sources of U.S. GAAP in a hierarchy for users to apply. ASC 105 provides for a single source of authoritative U.S. GAAP recognized by the FASB to be applied to nongovernmental entities in the preparation of financial statements. The Codification carries the same level of authority and supersedes SFAS 162 and all other accounting and reporting standards. The U.S. GAAP hierarchy has been modified to include two levels of U.S. GAAP: authoritative and non-authoritative.

On April 1, 2009, the Company adopted the provisions of the FASB ASC Topic 855, â€śSubsequent Eventsâ€ť (â€śASC 855â€ť), which requires the disclosure of the date after the balance sheet date but before financial statements are issued or available to be issued through which an entity has evaluated subsequent events and the basis for that date, that is, whether the date represents the date the financial statements were issued or were available to be issued. ASC 855 also alerts all users of financial statements that an entity has not evaluated subsequent events after that date in the set of financial statements being presented. The Company has evaluated subsequent events through November 2, 2009, the date the financial statements were available to be issued.

ASC 820-10-35 relates to determining fair values when there is no active market or where the price inputs being used represent distressed sales. It reaffirms what the objective of fair value measurement is to reflect how much an asset would be sold for in an orderly transaction (as opposed to a distressed or forced transaction) at the date of the financial statements under current market conditions. Specifically, it reaffirms the need to use judgment to ascertain if a formerly active market has become inactive and in determining fair values when markets have become inactive. The adoption of ASC 820-10-35 did not have a material impact on the Company's consolidated shareholdersâ€™ equity or net income.

ASC 825-10-50 enhances consistency in financial reporting by increasing the frequency of fair value disclosures. The guidance relates to fair value disclosures for any financial instruments that are not currently reflected on the balance sheet at fair value. Prior to issuing this standard, fair values for these assets and liabilities were only disclosed once a year. ASC 825-10-50 now requires these disclosures on a quarterly basis, providing qualitative and quantitative information about fair value estimates for all those financial instruments not measured on the balance sheet at fair value.

ASC 320-10-35 provides additional guidance designed to create greater clarity and consistency in accounting for and presenting impairment losses on securities. The guidance is intended to bring greater consistency to the timing of impairment recognition, and provide greater clarity to investors about the credit and noncredit components of impaired debt securities that are not expected to be sold. The measure of impairment in comprehensive income remains at fair value. ASC 320-10-35 also requires increased and more timely disclosures sought by investors regarding expected cash flows, credit losses, and an aging of securities with unrealized losses.

The adoption of ASC 825-10-50 and ASC 320-10-35 as of April 1, 2009, only required new disclosures to be made and did not have an impact on the Companyâ€™s consolidated shareholdersâ€™ equity or net income.

On January 1, 2009, the Company adopted the provisions of ASC Topic 810, â€śConsolidationâ€ť (â€śASC 810â€ť). ASC 810 requires all entities to report noncontrolling interests in subsidiaries (formerly known as minority interests) as a separate component of equity in the consolidated balance sheets, to clearly identify consolidated net income attributable to the parent and to the noncontrolling interest on the face of the consolidated statement of operations, and to provide sufficient disclosure that clearly identifies and distinguishes between the interest of the parent and the interests of noncontrolling owners. ASC 810 also establishes accounting and reporting standards for changes in a parentâ€™s ownership interest and the valuation of retained noncontrolling equity investments when a subsidiary is deconsolidated. Upon adoption of ASC 810, we recharacterized our minority interest as a noncontrolling interest and classified it as a component of shareholdersâ€™ equity in our consolidated financial statements.

On January 1, 2009, the Company adopted the provisions of ASC Topic 815, â€śDerivatives and Hedgingâ€ť (â€śASC 815â€ť). The provisions of ASC 815 amend and expand the disclosure requirements for derivative instruments and hedging activities by requiring enhanced disclosures about (i) how and why an entity uses derivative instruments, (ii) how derivative instruments and related hedged items are accounted for under ASC 815 and (iii) how derivative instruments and related hedged items affect an entityâ€™s financial position, financial performance, and cash flows. The effect of adopting ASC 815 was immaterial to our financial statements.

New accounting pronouncements issued during 2009 impacting the Company are as follows:

On June 12, 2009, the FASB issued FASB Statement No. 166, â€śAccounting for Transfers of Financial Assets,â€ť (â€śSFAS 166â€ť). SFAS 166 requires that a transferor recognize and initially measure at fair value all assets obtained (including a transferorâ€™s beneficial interest) and liabilities incurred as a result of financial assets accounted for as a sale. It is a revision to FASB Statement No. 140, â€śAccounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,â€ť and requires more information about transfers of financial assets, including securitization transactions, and where entities have continuing exposure to the risks related to transferred financial assets. SFAS 166 is effective on a prospective basis in fiscal years beginning on or after November 15, 2009 and interim periods within those fiscal years, and will be adopted by the Company in the first quarter of fiscal year 2010. The Company is assessing the potential impact, if any, of the adoption of SFAS 166 on its consolidated results of operations and financial condition.

On June 12, 2009, the FASB issued FASB Statement No. 167, â€śAmendments to FASB Interpretation No. 46(R),â€ť (â€śSFAS No. 167â€ť). SFAS No. 167 amends FASB Statement No. 46 (revised December 2003), â€śConsolidation of Variable Interest Entities,â€ť to require an enterprise to perform an analysis to determine whether the enterpriseâ€™s variable interest or interests give it a controlling financial interest in a variable interest entity. It determines whether a reporting entity is required to consolidate another entity based on, among other things, the other entityâ€™s purpose and design and the reporting entityâ€™s ability to direct the activities of the other entity that most significantly impacts the other entityâ€™s economic performance. SFAS No. 167 is effective on a prospective basis in fiscal years beginning on or after November 15, 2009, and interim periods within those fiscal years, and will be adopted by the Company in the first quarter of fiscal year 2010. The Company is assessing the potential impact, if any, of the adoption of SFAS No. 167 on its consolidated results of operations and financial condition.

In August 2009, the FASB issued Accounting Standards Update No. 2009-05, â€śMeasuring Liabilities at Fair Valueâ€ť (â€śASU 2009-05â€ť). This update provides amendments to ASC Topic 820, â€śFair Value Measurements and Disclosuresâ€ť for the fair value measurement of liabilities when a quoted price in an active market is not available. The ASU 2009-05 is effective for the first interim or annual reporting period beginning after the ASUâ€™s issuance, and will be adopted by the Company in the fourth quarter of fiscal year 2009. The Company is assessing the potential impact, if any, of the adoption of ASU 2009-05 on its consolidated results of operations and financial condition.

In September 2009, the FASB issued Accounting Standards Update No. 2009-12, â€śMeasuring Fair Value of Certain Investmentsâ€ť (â€śASU 2009-12â€ť). This update provides further amendments to ASC Topic 820, â€śFair Value Measurements and Disclosuresâ€ť to offer investors a practical expedient for measuring the fair value of investments in certain entities that calculate net asset value per share (â€śNAVâ€ť). Specifically, measurement using NAV is reasonable for investments within the scope of ASU 2009-12. The ASU 2009-12 is effective for the first interim or annual reporting period beginning after the ASUâ€™s issuance, and will be adopted by the Company in the fourth quarter of fiscal year 2009. The Company is assessing the potential impact, if any, of the adoption of ASU 2009-12 on its consolidated results of operations and financial condition.

Results of Operations - For the Three and Nine months Ended September 30, 2009 and 2008

The Companyâ€™s reporting currency is the U.S. dollar. The Companyâ€™s subsidiaries have one of the following functional currencies: U.S. dollar, Swiss franc, Euro, British pound, Canadian dollar, Indian rupee, or South African rand. As a significant portion of the Companyâ€™s operations are transacted in foreign currencies, fluctuations in foreign exchange rates may affect period-to-period comparisons. To the extent that fluctuations in foreign currency exchange rates affect comparisons, their impact has been quantified, when possible, and discussed in each of the relevant sections. See Note 2 to the consolidated financial statements in Item 8, â€śFinancial Statements and Supplementary Dataâ€ť, in the Companyâ€™s Annual Report on Form 10-K filed with the SEC on March 13, 2009, for a discussion on translation of foreign currencies.

Summary Overview
We generated net income attributable to Flagstone of $67.1 million and $170.7 million for the three and nine months ended September 30, 2009, compared to net loss attributable to Flagstone of $186.5 million and $111.7 million for the same periods in 2008. Our results of operations include the results of Flagstone Africa beginning in July 2008, the results of Flagstone Alliance beginning in October 2008 and the results of Marlborough beginning in November 2008. The increases in net income attributable to Flagstone for the three and nine months ended September 30, 2009 of $253.6 million and $282.4 million, respectively, as compared to the same periods in 2008 is primarily due to:
The increases in underwriting income in the three and nine months ended September 30, 2009, are primarily due to the absence of significant losses in the current year compared to the same periods last year in which we had incurred losses due to more catastrophic events, including gross losses related to Hurricane Gustav ($13.1 million) and Hurricane Ike ($129.6 million). The decrease in the net realized and unrealized losses on investment for the three and nine months ended September 30, 2009, were due to reduction of equities in our investment portfolio in the current year and the negative performance of the global equity markets in the same periods in 2008.

These items are discussed in more detail in the following sections.

As a result of our net income attributable to Flagstone for the nine months ended September 30, 2009, our diluted book value per share increased to $13.20 compared to $11.30 at December 31, 2008, representing an increase of 17.5%, inclusive of dividends declared during the period.

Outlook and Trends

With the global economic recovery underway, the third quarter saw continued replenishment of (re)insurersâ€™ capital and surplus positions, following on from generally profitable first and second quarters. This was aided by the relatively quiet Atlantic hurricane season thus far, as well as a lack of major reinsured loss events around the world. In the United States, tornado and hail loss activity, on the other hand, has continued to produce material losses for Midwest U.S. insurers, making 2009 nearly as bad as the record 2008 losses. The international cat market remains stable at this time with capacity programs paying a capacity charge, whilst the smaller regional programs remain competitive. There are signs of increased capacity returning to the market which is likely to halt any material rate increases. Specialty business is mixed, with some lines such as marine and aviation seeing rate increases, whilst others such as casualty remain soft and unattractive.

Barring any major global catastrophe events around the world in the fourth quarter and assuming the continued rebuilding of (re)insurers capital and surplus positions, we anticipate that this may translate into increased available capacity and flattening pricing conditions at the January 1, 2010 renewals.

The following tables provide a summary of gross and net written and earned premiums, underwriting results, total assets and ratios for each of our business segments for the three and nine months ended September 30, 2009 and 2008:

CONF CALL

Brenton Slade

Good morning ladies and gentlemen. Thank you all for joining us on the call today. With me are Chairman Mark Byrne, David Brown, our CEO and Patrick Boisvert, our CFO. Before I turn the call over to Mark, please let me remind everyone that statements made during this call including the questions and answers which are not historical facts may be forward-looking statements within the meaning of the U.S. Federal Securities laws.

Forward-looking statements contained in this presentation may differ from actual results. We therefore caution that you should not place undue reliance upon such statements. We speak only as of the date on which the statements are made and the company undertakes no obligation to update or revise publicly any forward-looking statement whether as a result of new information, future events or otherwise.

On that note, I would now like to turn the call over to Mark Byrne, our Chairman.

Mark Byrne

Folks, 2008 was obviously a challenging year. Our book value declined due to investment losses with the majority of those losses occurring in the third quarter and the first two weeks of the fourth quarter, all of which is old news. We saw that in mid October.

2008 was also a successful year for us organizationally with our acquisitions in South Africa, Cyprus and London and our restructuring into a Swiss operating company. Despite the macro economic global environment, we were able to continue to build and add to the quality of the platform. We now have over 400 people in 13 offices in 10 countries.

We believe this gives us a tangible edge in sourcing more risks in a diversified manner, analyzing those risks and making more informed decisions about underwriting. Ultimately this results in a diversified and high quality portfolio.

We believe our core underwriting results are strong in a highly active cat year with an 89.4% combined ratio. This clearly demonstrates the value created by our investment in industry leading technologies and a large staff, and our strong operating results are a direct result of this quality and efficiency in the global platform. Furthermore, we're pleased and excited about the continued diversification of our book and the further growth of our specialty line business.

In the early part of the fourth quarter, we announced the agreement to acquire Marlborough Underwriting Agency, operators of Syndicate 1861 at Lloyd's. That transaction has closed now and we are very pleased at the speed of integration. In fact, we expect Marlborough to add a nicely diversified book of business to our overall portfolio as of January 1. Marlborough writes a profitable book of specialty insurance and reinsurance; mainly engineering, aviation and marine and energy.

2008 organizational highlights also include purchasing and rebranding Imperial Re in South Africa, now called Flagstone Insurance Africa, an independently rate A- by AM Best and the purchase and integration of Alliance Re in Cyprus which is now named Flagstone Alliance Insurance and Reinsurance.

In the capital markets, we continue to make money and operate our side car business and have renewed those vehicles for another term as well as successfully issuing a very innovative UNL based self modeled cap on called Valley Re.

As I mentioned earlier, our book value decline was a result of investment losses in the third quarter and in the first two weeks of the fourth. We had no material exposure or losses from sub prime all day securities. Our losses were essentially due to our 23% allocation for the indices and the worst performance of those indices in a century, when our internal circuit breakers were tripped in early October, we made the decision to reallocate our asset portfolio to a very risk diverse portfolio where we remain today.

Our investment portfolio is now conservative, allowing us to take advantage of the hardening cycle in the reinsurance market and removing the uncertainly associated with the capital markets.

In hindsight, it was a good move and despite the further losses in October, we were able to avoid some of the further deterioration toward the end of the year. We expect to stay conservatively positioned on the investment side in 2009 with 90% of our assets in high grade fixed income securities. The proactive risk management was viewed in a positive context by our rating agencies.

We're disappointed in our financial results for 2008, but we're very encouraged at the bright prospects for 2009 given the favorable environment for our pricing and our move to conservatively position the balance sheet in preparation to take advantage of the opportunity.

With that summary, I'll turn the call over to David.

David Brown

Good morning everybody. The fourth quarter is pleasing from an underwriting perspective. We achieved a 44.6% loss ratio and a 75.8% combined ratio that produced an underwriting profit of $46.9 million for the quarter despite the negative developments of $25.5 million loss.

For the year, our loss ratio was 58.1% on a combined ratio of 89.4% producing underwriting profits of $73.4 million. This was achieved in one of the worst years ever for natural catastrophes and was actually benefits of releases from prior year's reserves.

Our net combined Ike and Gustaf loss now stands at $140 million, up from $115 million at the end of the third quarter. Although we're pleased that this adverse change of approximately 22%, it's less severe than reported by many of our peers, we're nevertheless disappointed with this development.

The increase comes predominantly from Midwest clients who have been late in reporting losses as they deal with what is a very unusual event for them.

Our written premium in the fourth quarter was $95.2 million which represents an increase of $46 over the same quarter last year and brings our total premium for the year to $781.9 million which is a 35% increase over 2007.

This acceleration of premium growth in the fourth quarter reflects the significant business production we are seeing from our global platform as well as falling prices, but it's important to note that it includes nothing from our newest and largest acquisition, Marlborough.

This growth in business continues into 2009 and we were very pleased with our business at January 1 as we were able to capitalize on the hardening market caused in general by the losses of 2008 and in particular, the difficulties being experienced by some of the major market participants.

We were able to grow our business into attractive markets; for example, the U.S. where so far in 2009 our premiums are up about 23% over the same period last year whilst the related aggregate exposure is down 3%.

We fully expect the market trend to continue as demand for U.S. cat reinsurance materially outstrips available supply as mid year approaches. This demand will be exacerbated by the continued material gap in the FACS' ability to provide subsidized reinsurance as well as new interest in frequency driven covers.

Our international book benefited from several of the larger players experiencing capital impairments and we found that in general, European win buyers paid up to 10% more on their rates. We took the opportunity to reshape our portfolio and we cut back on programs that were not attracting reasonable increases or being pursued by markets which are more aggressive in their pricing.

Our written premiums decreased very slightly in outlook terms due to the shifting currency as a major portion of our international portfolio is either in Euro or British Pounds. Overall, we were very pleased with this book of business as our aggregate exposure is lower by about 10% while our premiums are down only 3% with book reduction reflecting recent currency movements.

Looking at our overall portfolio, our current 1 in 100 net P&L is $244 million and our 1 in 250 is $323 million. Our book continues to diversify and this is reflected in the moderate P&L mix relative to our capital premiums.

Although we are not typically major users of retro sectional cover, in anticipation of the capacity crunch, we were proactive in arranging such covers early in the fourth quarter. We now have significant retro sectional protection covering losses on both an event and aggregate basis. This protection on some of our existing capital and our conservative investment portfolio positions us well to participate fully in the attractive markets we believe 2009 will present.

I'll now pass the microphone over to Patrick to discuss our financials.

Patrick Boisvert

Good morning ladies and gentlemen. I'm going to discuss some of the financial aspects of our fourth quarter results and of our current financial position. Let me start by referring you all to our investor financial supplement which is now posted on our website.

During Q4, our two business segments contributed in line with our expectations. Overall, our gross premiums written were $95 million, an increase of $30 million or 46% compared to the same period last year.

The increase was mostly driven by growth in specialty lines where premiums written totaled $35 million in Q4 2008 compared to $17 million in Q4 2007. As David mentioned, our combined ratio for the quarter was 26% including net adverse development on Ike and Gustaf of $25 million or 14 points. Excluding Ike and Gustaf, our consolidated net favorable reserve development for cat events was $6 million for the quarter.

Our operating income for Q4 was $44 million, generating an annualized net operating return on average equity of 17% for the quarter.

On the investment side, as you're all aware, we add up to FAS 159 and as a result, our realized and unrealized gains and losses on our investment assets are booked directly to the income statement. The metric we focused on is the total return of our investment portfolio.

Our total return for the quarter was negative 7.8%, most of which came from our losses on equities and commodities incurred early in October and before we took steps to reduce or eliminate our exposure to these asset classes. Our total return for the year 2008 was negative 13.9%.

Our year end diluted book value was $11.30, increasing by 10% in Q4 and by 17% in 2008 adjusted for dividends.

I would like to highlight that the return on our portfolio impacted our book value negatively by 12% in Q4 and 21% for the year. This was offset by positive impact on the book value from our underwriting result despite the significant cat activity.

Moving on to our balance sheet, our liquidity position is very strong with cash and cash equivalents at December 31, 2008 of $826 million. We continue to have no exposure to sub prime backed investments or collateralized debt obligations of sub prime backed investments and our holdings of securities at December 31, 2008 were $3 million with an average rating of triple A.

Finally, during the fourth quarter, we purchased 698,000 shares for a total consideration of $6.6 million. The timing and amount of future repurchase transactions will be based on our evaluation of a number of factors including share price and market conditions. We may decide at any time to suspend or discontinue the program.

And with that summary of the financials, I will now pass it over to the moderator to open the lines for questions and answers.